Bloomberg News

CEO Profit Skepticism Supports Weak Estimates for Stocks

A trader works on the floor of the New York Stock Exchange. Photographer: Michael Nagle/Bloomberg

Investors who want to know why U.S. equity strategists are the most pessimistic in a decade need look no further than statements by chief executive officers.

For every company predicting in January that earnings will beat analyst estimates, 2.5 are projecting results that fall short, matching the worst ratio since the rally began in March 2009, according to data compiled by Bloomberg. While analysts say Standard & Poor’s 500 Index profits will rise 8.8 percent in 2014, that’s almost the same estimate they generated a year ago for 2013, when earnings ended up increasing at about half that rate, the data show.

Diminishing income growth was cited by everyone from David Bianco at Deutsche Bank AG to Barclays Plc’s Barry Knapp in predicting a weaker stock rally for 2014. Last year, even as profit gains slowed to the lowest since 2008, the S&P 500 rallied 30 percent as valuations expanded. Best Buy Co., Lululemon Athletica Inc. and Bed Bath & Beyond Inc. have already cut earnings forecasts because of weak December results.

“People are saying sales weren’t that strong in the holiday season and they see weakness going forward,” Tim Hartzell, who helps manage about $425 million as chief investment officer at Houston-based Sequent Asset Management, said in a telephone interview. “If earnings slow down, then overnight, valuations become stretched.”

Earnings Season

Among the 52 companies in the S&P 500 that have reported results for last quarter, fewer are posting income that exceeds Wall Street forecasts: about 62 percent, compared with 75 percent in the previous period, according to data compiled by Bloomberg. Profit growth slowed to a quarterly average of 4.1 percent in 2013, down from 20 percent over the last three years, according to Bloomberg data.

Futures on the S&P 500 climbed 0.3 percent at 9:05 a.m. in London today.

Best Buy (BBY:US) in Richfield, Minnesota, has plunged 39 percent in January after U.S. same-store sales fell in the holiday shopping season as price cuts failed to draw as many shoppers as expected. Oppenheimer & Co. downgraded the stock (BBY:US) to market perform from outperform, saying sales declines amid aggressive promotions are a “stark reminder of vulnerabilities,” according to a note to clients on Jan 16.

“Earnings will matter more this year,” E. William Stone, chief investment strategist at PNC Wealth Management in Philadelphia, which manages about $117 billion, said in a phone interview. “We’re certainly not expecting a lot of multiple expansion. What should you get paid for now in the market? You should get paid for earnings growth.”

Economic Pressures

Family Dollar (FDO:US) Stores Inc. cut its profit forecasts after December sales fell about 3 percent on fewer customer transactions. Shares in the Matthews, North Carolina-based company, will fall 6.6 percent in the next 12 months, according to analyst estimates compiled by Bloomberg.

Shares of Bed Bath & Beyond (BBBY:US), based in Union, New Jersey, tumbled the most in 18 months on Jan. 9 after it forecast fourth-quarter profit that missed analysts’ estimates. The company also said third-quarter net income and comparable-store sales fell short of projections, after Black Friday shopping weekend saw its first spending decline since 2009.

Wall Street strategists predict the S&P 500 will rise 5.8 percent this year to 1,956, according to the average of 21 estimates compiled by Bloomberg. That’s the most pessimistic forecast since 2005, when strategists projected a 2.8 percent gain for the index.

Equity Strategists

Knapp, the head of U.S. equity strategy at Barclays, says the S&P 500 will rise 3.3 percent to 1,900 by the end of the year. He said in a note this month the market has already accounted for higher earnings growth. Deutsche Bank’s Bianco, who predicts the S&P 500 will end the year at 1,850, last month said he would be more bullish with a more convincing outlook for higher earnings growth or if stocks fell about 5 percent.

While corporate predictions now are worse than average, companies are historically more bearish than bullish. About 16 firms issued forecasts below analyst predictions for every 10 giving higher ones since March 2009, data compiled by Bloomberg show.

Should analyst forecasts hold, earnings in the S&P 500 will rise 8.8 percent in 2014 to the fourth consecutive annual record. At the same time, the U.S., Japan and the euro area economies will expand simultaneously for the first time since 2010, according to economist’s estimates compiled by Bloomberg.

Cost Cutting

Corporations that increased profit mainly by cutting costs last year are poised to benefit from an accelerating economy in 2014 and should meet or exceed earnings projections, according to John Manley, who helps oversee about $233 billion as chief equity strategist for Wells Fargo Funds Management in New York. Equities should also climb as the Federal Reserve maintains low interest rates amid faster growth, he said.

“You’re still going to get a kick from the cycle when the cycle kicks in,” Manley said in a phone interview. “It’s more likely that we get positive surprises than negative ones this year. We have at least a window where earnings can do well before the Fed responds in a restrictive way to the stronger economy, and that window of opportunity can be a full year.”

International investors are the most upbeat about the global economy than at any time in almost five years, buoyed by the U.S.-led revival of industrial nations, according to the Bloomberg Global Poll.

Investor Poll

On the eve of the World Economic Forum’s annual meeting in Davos, Switzerland, 59 percent of Bloomberg subscribers surveyed last week said the economic outlook is improving. That’s up from 33 percent in November and marks the most optimistic result since the poll began in July 2009.

Even with economists forecasting a pickup in growth, the U.S. won’t expand more than 3 percent through the next five quarters, according to data compiled by Bloomberg. That’s below the average growth rate since 1947 of 3.3 percent, including recessions.

The rally that has boosted stocks 172 percent since March 2009 has lasted almost a year longer than the average bull market since World War II, according to data compiled by Bloomberg. Valuations (SPX) for S&P 500 companies rose 23 percent last year to 17.4 times reported operating earnings, the highest level since May 2010.

“At this point the market is slightly over valued,” Kevin Caron, a Florham Park, New Jersey-based market strategist at Stifel Nicolaus & Co., which oversees $160 billion, said by phone. “Over time, it’s got to be earnings that drive stock prices. I would say earnings forecasts are going to come down with a very high level of certainty.”

To contact the reporters on this story: Nick Taborek in New York at ntaborek@bloomberg.net; Whitney Kisling in New York at wkisling@bloomberg.net

To contact the editor responsible for this story: Lynn Thomasson at lthomasson@bloomberg.net